New Wrinkle In Tax Reform Has Benefits People Baffled

"It's a cheap, blind-side shot from the bureaucrats," says Robert Souder of Rite Aid Corp. of Harrisburg.

"This is the first time the government has stepped into taxing benefits," says Gene Keidan of Benefits Resource Management of Pittsburgh. "It's also the beginning of a push for standard health plans for all."

"Few people understand it," says Ralph Pontillio of the Erie-based Manufacturers Association of Northwestern Pennsylvania. "Not even the experts. And it takes effect January 1."

Emotional words for what, at first glance, appears to be an obscure part of tax reform.

But tax experts say Section 89 will create staggering administrative costs for businesses, regardless of whether a company follows the code's rules, or does not and is slapped with penalties.

Section 89, in many ways, is the most onerous part of tax reform. It will tax something that the Internal Revenue Service never previously burdened, namely, employee benefits.

Thus, discussions were heated last week at the Sheraton East in Harrisburg, where 155 tax lawyers, accountants and personnel officers jammed into a conference on Section 89 sponsored by the Pennsylvania Chamber of Business and Industry.

In reality, Uncle Sam is taking his share of fringe benefits that companies offer to "fat cat" executives.

Section 89 is a two-part review process of benefits. The law requires employers - including all for-profit and non-profit organizations - to either provide health benefits in ways that do not favor "highly compensated" employees (those making more than $50,000) or to provide an income value for such extra benefits. Those extra benefits can then be taxed as if the highly paid worker had received them in salary.

For example, an executive who earns $100,000 a year, and receives what the government considers $10,000 in "excess benefits," would have to pay taxes as if he or she earned $110,000.

Companies ignoring the law or not developing plans acceptable to the government are subject to additional excise taxes equal to 28 percent of the value of incorrectly reported benefits.

The first, more simple, part of the law requires that businesses provide a written plan that adequately notifies workers of their benefits and the rights they have under the benefit program.

If a company's plan is unacceptable, all of its employees will have their benefits taxed as if those benefits were earned as wages. This segment of Section 89 does not exclude lower-paid workers; everyone in a company with an inappropriate plan must pay the penalty.

Companies whose plans are accepted by the government proceed to the second part of Section 89 - tests to assess the relative values of employees' benefits.

Benefit plans - including health and life insurance, tuition for continuing education, dependent care, voluntary employee beneficiaries associations and other fringe benefits - must satisfy an 80 percent test, where benefits are provided to at least 80 percent of those workers earning less than $50,000 annually.

If a company fails that test, there is a complex three-part process to determine if a benefits plan is discriminatory. If a company fails to meet any of these three standards, its plan is considered discriminatory and the "discriminatory excess" benefits are treated like taxable income for the highly compensated worker.

- The first step in the three-part test is a 50 percent eligibility test, where half of those workers eligible for benefits are not highly compensated.

- That is followed by a 90 percent/50 percent participation test, where 90 percent of the lower-paid workers must be able to participate in the same or similar plan as the highly compensated. They must also be eligible for benefits valued at no less than 50 percent of what the highly paid workers receive.

- Finally, a 75 percent comparative benefits test requires the ratio of benefits for low-paid employees to be at least 75 percent of the ratio of the benefits for highly paid employees.

For example, an executive earns $1,000 in benefits for every $10,000 in salary. To meet this part of the Section 89 requirement, employees of that company must earn $750 in benefits - 75 percent of the value offered the highly compensated workers - for every $10,000 in salary.

The average employee is off the Section 89 hook when the business files an acceptable plan (see graphic on D1). The employer must pass the secondary test for discriminatory excess to remove the potential burden from the highly compensated workers. Benefit plans are reviewed annually, so changes in employee benefit compensation must continue to meet Section 89 requirements.